FUND RAISING FOR SME & MID-CORPORATE

SECTOR

Group Study by:

- CA Nikhil Sahajwani

- CA Prakash Bhatia

- CA Resham Wadhwa

Introduction to SME & Mid Corporate Sector

General Definition/s of SME & Mid Corporate

• No Single Definition• Classification varies in each country, bank, industry

Classification Manufacturing Enterprises

Service Enterprises

Micro Upto Rs.25 lakh Upto Rs.10 lakh

Small Above Rs.25 lakh & upto Rs.5 crore

Above Rs.10 lakh &upto Rs.2 crore

Medium Above Rs.5 crore & upto Rs.10 crore

Above Rs.2 crore & upto Rs.5 crore

Source : Micro, Small and Medium Enterprises Development (MSMED) Act, 2006

RBI Classification

Increasing spirit of entrepreneurship causing this spurt..

Growing number of SMEs

Importance of SME & Mid Corporate Sector

Importance of SME & Mid Corporates

• SME & Mid Corporates are vital for growth of the country:

– Stepping stone of large enterprises– Creating an environment for entrepreneurship– Promotes innovation– Provides ancillary support to the large

corporates/PSU/Govt. – Generates employment even for uneducated class – Helps disperse income generation outside of big cities – Helps optimise the local resource base

Importance of SME -- India

• SME play vital role for growth of Indian economy by contributing 45% of industrial output, 40% of exports and employing 60 million people and creating 1.3 million jobs every year and produce 8000 quality products.

• Public Sector Banks have been advised to achieve a minimum 20% y-o-y growth in credit to the SME sector

• There is also special focus by RBI/Govt. for lending to priority sector

Importance of SMEs -- Globally • Globally, SMEs include over 90% of registered Business

Enterprises and 50-60% of Total Employment.

• In Europe, Japan and the USA, 90+% of the enterprises belong to the small business segment (<250 employees)

• Employment generated through Small businesses is more than 50% in the EU and approximately 40% in the USA

45-55% of formal SMEs in emerging markets are unserved, 21-24% are underserved (i.e., they identify financing as a constraint) and 16-20% do not need credit (Source: IFC)

Some Figures of Interest

• Bank lending to SMEs was Rs 5.4 trillion (one trillion equals 100,000 crore) as of January 2013. In March 2012, it was Rs 5.1 trillion. (Source: RBI)

• SMEs in India require Rs 32.5 trillion in financing

Of this 32.5 Trillion, 78 per cent comes from informal sources or is self-financed while only the remaining is met by banks and other institutions (Source: IFC)

• in 2011, 55 of the 77 commercial banks operating in the country failed to meet the RBI's target of 20 per cent growth in loans to SMEs. (Source: The Federation of Indian Chambers of Commerce and Industry)

SME & Mid Corporate Financing

- Borrowers Perspective

General Scenario

• Approx. 85% of SMEs in emerging markets suffer from credit constraints

• Approx. 70% of all emerging-market SMEs do not use any formal credit

• This means informal sector meets their financial requirements, though at times with stringent conditions

• Nearly 23.7% of SMEs disappear in two years and nearly 52.7% of SMEs exit the market in four years due to business failure, bankruptcy, or other reasons

(Estimates IFC 2010)

• Recent global economic downturn has further aggravated the problems already existed

• Financing assumes material role in SMEs

experiencing high growth prospects including opportunities for takeover

• Very few SMEs are able to finance their expansion through their Cash Flow and have to explore external sources of funding

• In credit filtration process SMEs are at a disadvantage

Issues of borrowers

• Percerption of higher risker lending by Lenders: Lack of successful track record and small size of resources of SME and Mid-Corporates creates a perception of greater credit risk among the banks

• High Rate of Interest: Banks and other financial institutions often charge higher rate of interest compare to large corporate due to perception of higher risk of SME/start ups/Mid-Corporates

• Collateral: SMEs lack the substantial asset base (collateral) to provide as security against bank loans– More pronounced for SMEs in the services sector

• Lower Sanction Limit: Normally sometime it has been observed that loan amount sanctioned is less compared to what is required by the business owners

• Bankers Rejection: Businessman feels that bankers have rejected proposals without any proper appraisal or investigation of potential of their business

• High Processing fees: small enterprises have to incur more processing and transaction cost than large firms

• Lack of Managerial Capacity: Managerial capacity to operate the business is the other obstacle for our country. Most of the businesses' managements do not have any degree/training either from the formal institutes or vocational learning centers.

• Increase in Contingency & Provisions

• Reduce the Loan Repayment Period by Bank as compare to Project Report

• Internal Rating & Reporting

• Sole Focus on Financials: i.e. looking at historical data to predict future creditworthiness. This approach has not been very successful in the SME sector to-date due to the fact that the financials provided by the applicant are often opaque given the cash nature of business transactions and incentives to under report income to save on taxes)

• Bureau Reporting: There are two kinds of credit bureau reports that can be generated – Individual and Corporate. only CIBIL currently provides reports, they cannot give relevant insights about an applicant who is a first time borrower

• Insufficient Working Capital Loan:- Example:Computation of Value of WC Requirement

DaysDebtors credit terms (does not include debtors of Rs. 4 crore more then 90 days of credit) 90Stock turnover 60

150

Less: Creditors Credit Term (60)

Assets Conversion Days 90

If the forecasted sales turnover is 100 crore , then the Working Capital Requirement will be 90/365 x 100 crore = 24.65 crore

Against the client requirement of Rs. 24.65 crore Bank Sanctioned only Rs.22.65 crore WC Limit so shortfall of Rs. 2.00 crore and also Owner has to fund Rs. 4.0 cr of debtors which are more then 90 days . In this Case Owner has to arrange Totally Rs. 6 crore

Delay in COD(Commercial Operation Date)

Proposed repayment schedule

Scheduled date of Completion of Project By March, 2014 Commercial Operations Date (COD) April, 2014 Implementation period (in months) October 2012 to March, 2014

(2 Years 6 Months) Moratorium (in months) April, 2014 to September, 2014

(6 Months) Repayment period in months/ quarters Q.E. December, 2014 to

September, 2021 (7 Years) No. Of installment 28 Quarterly Instalments Starting Date Q.E. December, 2014 End Date (Last installment)/ Repayment period

September, 2021 (7 Years)

Door to door tenor 10 Years

SME & Mid Corporate Financing –

CA’s Perpective

Role of Financial Advisor (CA)

SME promoters being technocrats, may not be finance savvy, and hence a Financial Advisor (CA) can a play major role in success of any project funding initiative as follows:

– Project Report• Project feasibility and viability reports (CMA Data)

• Liasoning with financial institutions (FIs) for securing the facilities

• Negotiating with FIs for best possible terms

• Availing specific schemes targeting SME’s/Mid Corporates

• TEV/Ratings, etc

– Location advisory for setting up unit based on incentives– Designing capital and tax structure– Risk management and planning hedging strategy

Project Report Contents

The Project report submitted to the bank forms the basis of banks decision and hence the need to prepare a comprehensive presentation including:

• Company Overview, Vision/Mission, Org Chart• Management/Promoter Profile• Shareholding pattern of the company • Project Details

– About the Project– Project Cost

» Cost of Land» Construction and Other Setting up expenses» Plant and Machinery» Working Capital

– Means of finance

Project Report Contents contd..

• Industry Analysis• Technical Feasibility

– Location advantages– Size of the plants/Proposed Facilities– Lay out– Prospective Supplier list– Method of Production– Types of Production Plants– Equipments

• Operational Aspects• SWOT Analysis• Conclusion and Recommendation

Number of SMEs

Sector/ Parameters Mfg. Others

Current Ratio (min.) 1.33 1.20(For FBWC limits above Rs. 5cr)1.00(For FBWC limits upto Rs. 5cr)

TOL/ TNW (max.) 3.00 5.00

DSCR Net (min.)Gross (min.)

2:11.75:1

2:11.75:1

Debt/ Equity Ratio 2:1 2:1

Promoters’ contribution* (min.)

30% of Equity

20% of equity

Credit Appraisal Standards to be observed..

Internal Credit Ratings

Source: SBI

CIBIL Score

• Credit Information Bureau Limited is India’s first Credit Information Company founded in August 2000.

• CIBIL collects and maintains records of an individual’s payments pertaining to loans and credit cards.

• CIBIL issues a 3-digit credit score and Credit Information Report (CIR), used extensively by banks

• CIBIL score ranges from 300 to 900 and indicates credit worthiness of the individual.

• Lenders prefer those with CIBIL score more than 700.

Techno Economic Valuation (TEV Study)

• Evaluating technical viability of a project broadly requires analysis of following parameters:

– Technical Feasibility  – Economical Feasibility  – Financial Feasibility  – Operational Feasibility 

• TEV study is a risk mitigation task undertaken in respect of any industrial/commercial activity prior to decision by bank, whether to lend or not

• The purpose of TEV Study is to provide utility to the sanctioning authority to conclude at an informed judgment as regards acceptance of the project for lending (or investment) purpose and to take a view on the acceptability of risk level. .

Steps to Debt Funding

Receipt of application from applicant|

Receipt of documents(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA,

and Properties documents)|

Pre-sanction visit by bank officers|

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc.

|Title clearance reports of the properties to be obtained from empanelled

advocates|

Valuation reports of the properties to be obtained from empanelled valuer/engineers

|Contd… 

Steps to Debt Funding contd..

|

Preparation of financial data

|

Proposal preparation

|

Assessment of proposal

|

Sanction/approval of proposal by appropriate sanctioning authority

|

Documentations, agreements, mortgages

|

Disbursement of loan

|

Post sanction activities such as receiving stock statements, review of accounts, renew of accounts, etc

(on regular basis)

Challenges Faced by Financial Advisor (CA)

• Remuneration and quantum of work on a proposal is not in proportion most often

• Limited options for Direct Equity fund raising:− Paucity of private equity investors for SMEs− Reluctance by SME to dilute their share holding

• Promoters with less education not very effective in backing picture presented by financial advisor to bank

• Banks have multiple reasons to reject a proposal hence Financial Advisor may be hesitant to take up green-filed assignments

SME & Mid Corporate Financing

- Bankers Perspective

Challenges faced by Banks Bank reluctant to lend for number of Reasons:-

• Information on SME is asymmetric & inconsistent• Lack of comparative data• Transaction Data – Not all transaction data captured

in data & credit history as it is done in USA through credit bureaux

• High cost of acquiring information compared to large corporate

• Not all enterprises are professionally driven• Average Financials,lower ability to absorbs shocks• Low Capital Base & promoters averse to equity

dilution• Higher risk of default and late payment in SME and

Mid-Corporate segments

Parameter considered in Financing

Financial and non parameters

Financial•Turnover•Profitability amount and margin•Net worth•Debt-Equity ratio and constitution of Debts•Working capital cycle•Financing model of company•Cost components and behavior of various cost like forex fluctuation, material cost, Fixed and variable cost etc•Cash flow in the company v/s Profits as per P&L

Non Financials

Critical Criteria Character & Borrower’s Position

• Character - Willingness to Pay• Capital - Risk-bearing Commitment• Cash flow – Ability to Pay / Cash Flow Adequacy• Collateral - Priority of Charge and Value• Condition - Business Model and Industry Trend

•Banker reference•Promoters background•Trade Reference•Vintage in business•Technological changes in industry like Mobiles•First all client data collected and tested against this parameters and then submitted for approvals.

Assessment

•  Check transaction history for last six months of all banks• Evaluate the transaction pattern in Current accounts through factors such as no. of chq returns, average balance maintained, Variation in month balance maintained, No. of credit inflows in the account, credit summations•  Assigning score to borrowers• Score for sanction to be checked and depend upon the same, the limits to be assign• Credit limit is sanction for company and for different facilities•  Security offered as collateral for loan

Approach and Old method of lending

(it is still followed by to a certain extent in Co-operative and Small and Mid size PSU Banks)

• Branch client relationship plays important role

• Branch centric mode

• More based on the Gut feeling of bankers

• Many times it is time consuming

Approach and method of lending

Recent Trends in SME Financing Models by Bank:-

• Separate SME group in banks • Market segmentation i.e. By size, sector, turnover• Credit scoring models• Decentralisation of decision making • Parameterised products• Portfolio approach – lending programme based on

industry specific assets to control industrial exposure• Supply chain financing, • Value added service and cross selling• Technology and automation, innovative product lines• Centralised monitoring and credit and risk team• Centralised or Zone based processing like trade

service and transaction processing• Optimise cost of coverage and servicing

Bank’s Products to SME – Assets Side 1. Long Term Finance2. Working Capital Finance3. Trade Service4. Treasury Products5. Parameterised Products6. Channel Finance7. Corporate Linked business8. Cash Management Servies The Above include both Fund based and Non Fund based products 

Long term Finance: External commercial borrowing

ECB is Foreign currency is the term loan offered for fresh capital expenditure by corporate except few industries specified by RBI

• Suitable for corporate having future earnings in USD• Floating rates of interest linked to LIBOR• IRS will help to convert to Fixed Rate of interest• RBI Cap on Pricing, based on average maturity• Repayments can be structure

External Commercial Arrangement• ECA is credit line to Indian bank from foreign bank mostly

EXIM bank • For specified end use and linkage like Solar Energy• It will be like ECB offered at comparative cheaper price if

corporate or it project qualifies for specified linkage

Long term Finance:Foreign currency term loan

Foreign currency term loan offered for capital expenditure incurred outside India by Corporate

Suitable for :• Corporate looking for acquisitions or takeover of foreign

companies in overseas

• Asset purchase like of Mines, Brands/IP, Ships etc

• Floating rates of interest linked to LIBOR Linked.

• IRS will help to convert into Fixed interest Rate

• Major comfort is build on the existing free cash accruals of parent company in India

 Rupee term loan

• Rupee term loan offered for capital expenditure and takeover of existing term loan by corporate in India

• Floating rates of interest linked to base rates of banks• Suitable for corporate having future earnings in rupee

and using indigenous items in capex• Monthly repayment of Interest payment• Repayments can be structured

WORKING CAPITAL FINANCE

All business needs a healthy cash flow to fund their every day requirement, with money tied in the stocks and debtors

It can be difficult to access cash as when required which can be fulfilled by Working capital finance

 Working capital required by business

1.  Procure raw materials & other services and expenses

2.  Payments to labours and staff

3.  Maintenance of stock, WIP, Stock of RM

4.  Delivery of goods, maintain sales channels

Net working capital

NWC is excess of long term sources over long term use. It is margin money for long term source towards working capital

NWC = current Assets – Current liabilities

NWC = (Net worth + Long Term borrowing) minus (Fixed Assets & Non Current Assets)

There are basket of products for working capital finance • Cash credit, Overdraft, Working Capital Demand Loan• Working Capital Term Loan• Buyers Credit• CMS• FCNR ( B)• Factoring• Export and import trade Finance

Cash Credit Accounts

• Drawing power is based on value of stocks and debtors minus required margin

• The day to day inflow of funds are routed through CC a/c. Lending bank keep track of a/c through monthly stock/ book debts statements

Bills Discounting• Bank finance short term trade transactions by

discounting, Hundi /Bills, the title of goods & accepted hundi /invoice on the genuineness of trade and associated documents

Non Fund Based Products

There are basket of Non fund based products are as follows:

• Letter of Credit – sight and usance• Bank guarantee- Financial and Performance• Stand By Letter of Credit for funding working

capital requirement• Derivative limits for hedging

Export Credit

Pre – Sale Finance·       Cash credit (for stock)·       Demand Loan·       Packing credit·       Purchase bill discounting·       Letters of credit (usance)Post Sale finance·       Cash credit (book debt)·       Bill purchase/discounting·       Factoring / Forfaiting·       Post shipment finance

Corporate Linked business

Vendor Finance•It involves financing supply chain partners who are associated with several large corpoates like FMCG, petroleum, Engineering by discounting the receivables of corporate vendors. The normal tenor is 30 to 90 day

•Vendor submit the copy bills to bank, bank check the correctness and fund to vendor and corporate directly pays to bank on time

Channel financing•The receivable of corporate are funded that is on acceptable terms of corporate the money payable by the sales channels like dealers, stockist, distributors.

•Dealer pays back to bank on liquation of stock or on or before due dates as banks has paid on their behalf. It is there for 7 to 90 days

Working Capital Assessment

Turnover Methods• Fund based limits, 20% of projected annual turnover

Cash flow GAP method• Based on cash flow projection, pure cash transaction,

Bank fund gap in cash flow in business operations

• Mainly used for seasonal industries for ex. Sector like sugar, project based limits, financing specific projects or where sales and purchase is not uniform

Working Capital Gap Method

 Two methods 1 and 2, required study of business operation, depending upon holding inventory and debtors cycle and creditors limit. RBI has introduced Maximum permissible Bank Finance (MPBF)

MPBF is an assessment method that mandate the cap (maximum amount) on the working capital availed by the borrower. This cap is based on an objective assessment of company needsTwo methods of MPBF1st methodQuantum bank finance is restricted to 75% of the working capital gap. WCG is CA – Current borrowing (other than bank borrowing)2nd MethodWCG = (75% of CA) - Current borrowing (other than bank borrowing)

Observation post disbursement

•     Non-objection of Letter acknowledging debts

•  Non submission or late submission of stock statement and QFI and Annual accounts•        Not in proper formats•        Problem in Security creation•        Modification in terms sanctions•        Delay in execution of documents•        Delay in release of security•        Improper security papers

Post sanction formalities

• Stock statement submission•        End use of term loans•        Unit Inspection- Planned 7 surprise•        Stock audit and receivable audit•        Asset quality review•        Insurance Coverage•        Adherence to other sanctions terms/covenants•        Pre checking of documents before submitting to banks•        Adherences of RBI Guidelines and regulations• Disclosures of materials and non materials information to banks relation to business of client•        Follow compliance guidelines of the banks•        Answer to clarification seek from the bank•        Supports for Timely renewal completion

CONCLUDING REMARKS..

In Conclusion..

Borrowers expect banks to be: • Flexible in approach/operation and low cost• Educated about all kinds of businesses • More innovative products, personalised service & attentionBanks expect from customers:• To submit the proper, all relevant & correct documents

(financial & non financial) information alongwith proposal• Keep bankers informed of major development• Borrowers should keep their Financial, Accounts,

Compliances and legal departments more carefulFinancial Advisor’s (CA) role is to use his knowledge and

experience to bridge this gap; End result should be to raise funds at a reasonable cost and ensure bank is at ease

THANK YOU

WORKING CAPITAL CASE STUDY

Creditors for Purchase 100 Raw Material 200Other Current Liability 50 Stock in Process 20Bank Borrowings 200 Finished Good 90

Receivables 50Other Current Assets 10

350 370

Total CA 370 Total CA 370 Total CA 370

Less : Total CL - Bank Borrowing 150 Less : 25% of CA 92

Less : Core CA from long Term Sources 95

WCG 220 WCG 278 WCG 27525% of WCG from Long Term sources 55

Less : Total CL - Bank Borrowing 150

25% of Long Term sources 69Less : Total CL - Bank Borrowing 150

MPBF 165 MPBF 128 MPBF 56Current Ratio 1.17:1 Current Ratio 1.33:1 Current Ratio 1.79:1

Current Liablities Current Assets( Rs. In lacs )

Ist Method 2nd Method 3rd Method

Maximum Permissible Finance Method (Tandon Committee )

75% of the working capital gap (WCG = Total current assets – Total current liabilities other than bank borrowings) is financed by the bank and the balance 25% of the WCG considered as margin is to come out of long term source i.e. owned funds and term borrowings. This will give rise to a minimum current ratio of 1.17:1. The difference of 0.17 (= 1.17 – 1) represents the borrower‘s margin which is known as Net Working Capital (NWC).

Bank will finance maximum up to 75% of total current assets (TCA) and borrower has to provide a minimum of 25% of total current assets as the margin out of long term sources. This will give a minimum current ratio of 1.33:1. This is same as 2nd method of lending, but excluding core current assets from total assets and the core current assets are financed out

of long term funds of the company. The term ‗core current assets‘ refers to the absolute minimum level of investment in current assets, which is required at all times to carry out minimum level of business

activity. The current ratio is further improved to 1.79:1

NPA Management

• The Narasimham Committee recommendations were made, among other things, to reduce the Non-Performing Assets (NPAs) of banks

• To tackle this, the government enacted the Securitization and Reconstruction of Financial Assets and Enforcement of Security Act (SARFAESI) Act, 2002

• Enabled banks to realise their dues without intervention of courts

SARFAESI Act

• Enables setting up of Asset Management Companies to acquire NPAs of any bank or FI (SASF, ARCIL are examples)

• NPAs are acquired by issuing debentures, bonds or any other security

• As a secured creditor can serve notice to the defaulting borrower to discharge his/her liabilities in 60 days

• Failing which the company can take possession of assets, takeover the management of assets and appoint any person to manage the secured assets

• Borrowers have the right to appeal to the Debts Tribunal after depositing 50% of the amount claimed by the second creditor